What is financial inclusion?
Financial inclusion is the state in which all individuals can access and use financial services that improve their wellbeing. The financial services, which include payments, savings, credit and insurance, should be appropriate, affordable and provided responsibly. Work to advance financial inclusion generally focuses on low-income and marginalized populations such as women, migrants and refugees, smallholder farmers and other unbanked or underbanked people who have been excluded from the formal financial system.
Why is financial inclusion important?
People need financial services to help them manage their financial lives and meet their goals, from covering day-to-day expenses to saving for the future to protecting their families from shocks. Research shows that formal financial services help low-income and vulnerable populations to:
- Save money and keep their savings safe, helping households to manage irregular cash flow and smooth consumption, as well as prepare for the future.
- Send and receive money through payment services, including family remittances and government support.
- Plan and pay for regular expenses such as utilities and education.
- Finance small businesses or microenterprises to help them grow.
- Handle and recover from emergencies with unexpected expenses.
How is financial inclusion connected to the Sustainable Development Goals (SDGs)?
Financial services form part of the foundation needed to meet a broad range of development goals. While financial inclusion is not listed as one of the SDGs in and of itself, it is recognized to be a key enabler for achieving several of them. Seven of the SDGs explicitly include financial inclusion as a target:
Eradicating poverty
Ending hunger
Good health and well-being
Gender equality
Decent work & economic growth
Industry, innovation & infrastructure
Reducing inequalities
Financial services can help people gain access to important services they need, including healthcare, education and utilities such as electricity and water and sanitation.
Health
Health financing products, insurance and savings provide ways for people to manage health expenses. Many MFIs also support their clients’ health needs through non-financial services, including health education and discounts on medical services. Financing for water and sanitation services can also help improve clients’ health and contribute to Sustainable Development Goal 6: Clean water and sanitation.
Education
Access to a quality education, which is Sustainable Development Goal 4 and a crucial element for progress out of poverty, can be supported through financial inclusion. Student loans, digital channels to pay school fees and other financial services can help low-income families to manage educational expenses. In addition, loans for low-cost private schools, which provide education for many low-income families but have limited access to financing, help these schools to grow and improve their educational offering.
Affordable & Clean Energy
Digital financial services and the development of pay-as-you-go models for solar energy have been crucial for the expansion of access to affordable and clean energy, which is Sustainable Development Goal 7.
What is microfinance and how does it relate to financial inclusion?
Microfinance refers to the provision of financial services to the poor. The term originates from the microcredit movement which began in the 1970s to provide small short-term loans for microentrepreneurs to start up or grow small businesses, usually in the informal economy. As the movement took off and numerous microcredit initiatives were formed around the world, experience and research began to reveal the limits of microcredit for poverty alleviation, along with a recognition that poor households need access to a range of financial services, not just credit. The term microfinance began to be used to refer to the broader set of financial services designed for poor people, including savings, credit, payments and insurance.
The concept of financial inclusion goes broader still, referring to all the work which goes into making sure that poor people have access to and can use the financial services they need. Going beyond a focus on microfinance institutions, financial inclusion involves multiple different actors, including policymakers who ensure the regulatory and supervisory environment for financial inclusion, and fintechs and other non-traditional financial service providers.
Financial inclusion covers a range of financial products and services
Credit
Credit - in particular, small loans for productive purposes such as growing a microenterprise - is the original financial product with which the microcredit movement began. Microloans are offered both to individuals and to solidarity groups who guarantee each other’s loans.
Housing Finance
As the sector has evolved, different types of credit products have been developed by microfinance institutions and other FSPs. Housing finance is an important product for many families, as a home can be one of their most significant expenses. These types of loans generally provide funds for incremental building, such as renovation or expansion of a home, construction or basic infrastructure improvements.
Agricultural Finance
Smallholder farmers and other rural enterprises usually require a different type of product from the typical short-term microcredit loans that involve frequent repayments. Agricultural finance adapts loan terms to the characteristics of farming as a livelihood, taking into account the seasonal nature of the business, timing of inputs needed and other unique aspects of rural and agricultural life.
Savings
The need for a safe place to save is universal, regardless of income level. Unfortunately, formal savings services are not accessible for many poor people. Informal savings, therefore, play an important role, especially savings groups which are common in much of the developing world. However, formal savings accounts are growing in developing countries, as digital financial services help to make it more viable for FSPs to offer small balance savings accounts.
Insurance
Insurance helps people manage different types of risks - from health to home to livelihood. Though poor people are more vulnerable to a wider range of unexpected events, they have little access to insurance. To address this need, many MFIs have partnered with insurance companies to offer microinsurance products. Health, life and credit life insurance are the most popular product lines within microinsurance.
Payments
Payment services have emerged as an important financial service for the financial inclusion sector, especially digital payments which can make transactions safer, faster and more convenient for low-income people. Facilitating money transfers from one actor to another, payment services are used by individuals, businesses and governments. They can help governments provide cash transfers to vulnerable populations, help households pay for utilities, help family members send money home, and help microentrepreneurs to do business.
Remittances
Remittances are a type of payment sent across borders, usually by family members outside of their country of origin who have migrated for better economic opportunities. Many families around the world depend on remittances as a key source of their household income. Remittances can thus play an important role in financial inclusion by bringing more people into the formal financial system and helping them achieve their goals. Each year, the total amount of remittances sent globally far surpasses the amount of official development assistance.
Islamic Finance
Islamic finance, also known as Sharia-compliant finance, is the set of financial products and services that follow Islamic law. A key principle is that money has no intrinsic value and cannot increase in worth on its own, meaning that interest can not be charged or earned. Sharia-compliant financial products are thus designed to be asset-based rather than debt-driven, with risk and profit sharing encouraged through equity participation in a business. While there is growing demand for this type of finance among the millions of Muslims living in developing countries, Islamic finance only accounts for a very small percentage of global microfinance services.
What is digital financial inclusion?
Financial services are increasingly available digitally - through mobile phones, point-of-sale devices and networks of small-scale agents. Digital financial services have the potential to expand financial inclusion significantly due to the lower cost of reaching more unbanked and underbanked people where physical bank branches are unavailable. Sub-Saharan Africa is a particularly active region for mobile money, where 33 percent of adults now have a mobile money account.
Institutions that provide financial services directly to low-income clients include MFIs and other financial service providers (FSPs), such as commercial banks, postal banks, credit unions, non-profit organizations and other types of entities depending on each country’s regulatory context. Fintechs, mobile money operators and other digital financial service providers are expanding their reach among low-income customers, and tend to work either in partnership with an established FSP or on their own.
International microfinance organizations provide funding and other types of support to their partner institutions around the world. Examples of these networks include FINCA International, Accion, Opportunity International and Women’s World Banking.
Most countries which have active microfinance sectors also have national or regional associations of MFIs which do advocacy for and support their members within the country or region. For example, the Association of Microfinance Institutions of Kenya (AMFI-K) has over 50 members among banks, MFIs, credit-only institutions and other categories. The Microfinance Council of the Philippines (MCPI) is a network of 66 institutions including microfinance NGOs, banks, cooperatives and support institutions. Regional microfinance associations include REDCAMIF for Central America and the Caribbean, Sanabel for the Arab World and the European Microfinance Network and Microfinance Centre for Europe.
A broad range of institutions provide funding for the financial inclusion sector, including development agencies, philanthropies and investors. Public funders include multilateral organizations such as UNCDF, UNDP and IFAD; bilateral agencies such as USAID, GiZ and UK Aid; and development finance institutions (DFIs) such as the African Development Bank, the IFC and the Asian Development Bank (ADB). Philanthropic funding comes from private donor foundations such as the Bill & Melinda Gates Foundation, Mastercard Foundation and MetLife Foundation.
Private investors also support the financial inclusion sector through microfinance investment vehicles (MIVs), such as Oikocredit, responsAbility and Triodos, and other impact investors. Microfinance has become one of the most advanced asset classes within impact investing, with investments providing debt and equity funding, as well as guarantees, for FSPs and other types of business models which provide financial services for the poor.
The legal and regulatory environment is crucial for financial inclusion to progress, and policymakers in each country play an important role in the sector. As governments recognize the importance of financial inclusion for economic development and financial stability, many have created National Financial Inclusion Strategies. International organizations supporting the development of supportive policies for financial inclusion include the Alliance for Financial Inclusion (AFI), the Global Partnership for Financial Inclusion (GPFI) and Toronto Centre.
Many other organizations provide different types of advisory services for the financial inclusion sector, including research and support for experimentation, technical assistance, knowledge sharing and capacity building.
For example, CGAP is a global partnership of more than 30 leading development organizations that works to advance the lives of poor people, especially women, through financial inclusion. The Center for Financial Inclusion is a global think tank which uses research and advocacy to advance inclusive financial systems for low-income people around the world. MicroSave Consulting (MSC) is a consulting firm that works towards meaningful financial, social and economic inclusion. The European Microfinance Platform (e-MFP) is a network of organizations and individuals which fosters knowledge-sharing, partnership development and innovation. ADA is a Luxembourg-based NGO which implements inclusive finance projects to strengthen the autonomy of vulnerable people and improve their living conditions.
Financial inclusion targets the unbanked and underbanked
The financial inclusion sector focuses its efforts on people who have traditionally been excluded from the formal financial system, including low-income and rural populations, women, smallholder farmers, micro, small and medium-sized enterprises, migrants, refugees, youth and children.
Women’s empowerment has long been a goal of microfinance initiatives around the world. Gender norms in many countries prevent women from participating fully in the financial system, leading to a gender gap in access and use of financial services. FSPs, donors and practitioners, including the community of practice FinEquity, are working to identify innovative approaches to help address the barriers women face and close the gender gap.
Smallholder farmers represent the largest client segment by livelihood of those living on less than $2 a day. However, rural populations can be difficult for financial institutions to reach and serve due to their remoteness, poor infrastructure and other limitations. New service delivery models, with innovations in technology and digital finance, are making rural and agricultural finance more viable.
Over 281 million people globally live outside their country of origin, having migrated for a number of reasons including economic opportunity and family. Almost 90 million of these migrants are refugees who were forcibly displaced from their homes due to conflict or persecution. Many have difficulty accessing financial services as financial institutions perceive them to be too risky to serve. However, several organizations are working to further financial inclusion among migrant and refugee populations by providing policy recommendations, evidence for the business case and guidelines for FSPs.
37 percent of young adults (aged 15 to 24) in developing countries are excluded from the formal financial system. Barriers to access for youth include regulatory restrictions, know your customer (KYC) requirements and low levels of financial literacy. However, many FSPs do provide specialized services for this population, including child and youth savings accounts and education loans.
While small and medium-sized enterprises (SMEs) form the backbone of most economies, the majority of SMEs in developing countries have trouble accessing the financing they need. These businesses are often referred to as the “missing middle” because they are too big to access loans from microfinance institutions, yet considered too small or risky for most commercial banks.
In order to reach these segments and provide them with services that meet their needs, financial service providers must make efforts to be customer-centric, with product development processes which aim to understand their clients and design products based on their reality. In-depth client research, such as the Financial Diaries methodology, is important for learning about how poor people manage complicated financial lives and providing insights that help FSPs design appropriate financial services.
What is the impact of financial inclusion?
How do we know if financial inclusion efforts are having a positive impact for low-income and marginalized people around the world? Impact assessments are studies which aim to evaluate the changes - whether positive or negative - which can be attributed to a particular financial inclusion intervention. There is a wide range of types of studies, from simple program evaluations conducted by implementing organizations, to randomized control trials (RCTs) which are generally run by trained academics and provide the most accurate assessments.
At a high level, studies have shown consistently that savings, insurance and payment services can help poor people build resilience and capture opportunities. Evidence for the impact on more specific outcomes such as income, employment and entrepreneurship, however, is mixed, especially for credit.
There is still a lot we don’t know about how financial services create impact, for whom and in what circumstances. While many impact studies show positive results, they often have a narrow focus on specific products or populations which make it difficult to draw broader conclusions about the impact of financial inclusion. There is a need, therefore, for more extensive research on outcomes which can be correlated with the use of financial services.
Financial health
As practitioners and policymakers continue to try to understand how financial services affect consumers, the concept of financial health - or wellbeing - has emerged as an important area of study. Financial health is defined as the extent to which a person or family can smoothly manage their current financial obligations and have confidence in their financial future. Though few studies have focused solely on the financial health of low-income populations, the data available thus far from related research indicates that there are serious deficits in financial health around the world.
Social performance
Social performance is another area which addresses the question of whether microfinance services are creating value for clients, this time from the perspective of the financial service provider. Social performance management refers to the systems in place for organizations to make sure they achieve their mission and put customers at the center of strategy and operations. The Social Performance Task Force (SPTF) and CERISE have developed a set of Universal Standards for Social Performance Management.
What role can financial inclusion play in addressing climate change?
Financial inclusion has the potential to help build resilience - both individual and collective - to the harmful effects of climate change, as well as support the transition to low-carbon economies. Access to a full range of financial services can provide a safety net to protect clients from changing weather patterns, natural disasters and shifting economies.
MFIs and other FSPs who work directly with low-income populations in developing countries are well-positioned to provide non-financial services as well, such as training and technical assistance, which can help clients adapt to climate change.
Financing and payment innovations such as pay-as-you-go business models can help make green technologies, like solar energy and cleaner cookstoves, more affordable for low-income people.
What are some of the major issues for financial inclusion policy?
As the financial inclusion sector evolves, the policies and laws which regulate and monitor the sector must evolve as well. With the growth of digital financial services and new actors such as fintechs operating in the financial inclusion space, regulators have had to become more flexible, adapting existing regulations and in some cases, creating new laws and regulatory bodies. The challenge is to create an enabling environment that protects low-income customers while also supporting innovation and keeping up with rapid technological change.
Consumer protection is a key issue for financial inclusion policymakers, who need to keep up with the growing and changing set of risks customers face with new technology and ways of accessing financial services. Financial health, which can include aspects of consumer protection, is becoming an important overarching concept to help financial sector policymakers look at how financial services affect consumers and consider ways to ensure the financial system supports people’s wellbeing.
What are some of the main challenges facing microfinance institutions?
As new types of players, such as fintechs and commercial banks, have entered the financial inclusion space and begun offering financial services to people on low incomes, MFIs have faced new challenges to their business models. For most small to medium sized MFIs, a major issue is adapting to the digital era and reaching scale. The digital transformation process is more than just automating a few manual systems; it requires serious investments in upgrading older management systems and rethinking ways of doing business. These changes can be expensive and difficult to implement; however, they are necessary if MFIs are to compete with newer entrants to the market and become more resilient.
Other challenges faced by MFIs include access to funding to invest in digital transformation processes and other necessary improvements, client overindebtedness, and data protection and privacy concerns. External factors, such as government policies, macroeconomic conditions and natural disasters, can also significantly impact MFIs.
What kind of data is available on financial inclusion?
Financial inclusion data gives us the information we need to understand how far we have come in expanding financial inclusion, and what remains to be done.
Demand-side datasets provide information on customers and how they behave. These include the World Bank’s Global Findex, the CGAP Smallholder Families Data Hub and the FinMark Trust Data Portal.
Supply-side datasets provide information on financial service providers and what they offer. These include the IMF’s Financial Access Survey, the CGAP Pulse Survey of Microfinance Institutions, conducted to capture the impact of COVID-19 on MFIs, and MIX Market Data.
Information on the funding landscape for the financial inclusion sector is also available in CGAP’s dataset, Trends in International Funding for Financial Inclusion.